enhancement of the business environment in the … · ebesm project 2. what are global value chains...

ENHANCEMENT OF THE BUSINESS ENVIRONMENT IN THE SOUTHERN MEDITERRANEAN

Global Value chains: An overview and Lebanese experience. Fadi Fayad Beirut 10.10.14

EBESM Project 2

What are Global value chains

Global value chain (GVC)?

• The value chain describes the full range of activities that firms and workers do to bring a product from its conception to its end use and beyond. This includes activities such as design, production, marketing, distribution and support to the final consumer.

Those activities can be contained in one entity or several entities;

The fact that they are increasingly spread over several countries explains why the value chain is regarded as

“global”.

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What are global value chains

Activities could be part of the same firm but in a different location or can be more complex ;

Outsourced from a different firm or entity; that

Itself might need to outsource from another entity possibly in a different country.

By relocating production processes in different countries, transnational corporations (TNCs) or MNC can take advantage of the best available human or physical resources in different countries, with a view to maintaining their competitiveness by improving productivity and minimizing costs

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What are Global value chains?

GVCs are based on the principle of generating added value at the various stages of the value chain and operate by the concept of comparative advantage;

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GVC Actors

At the macro/meso level

Policy makers

Public services

Supporting services:ICT, logistics

AT the micro level

Workers.

Firms

MNC

Researchers and research centers.

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Why should developing countries be interested in GVC?

• Global value chains have become much more prevalent and elaborate in the past 10 to 15 years. While many firms have had international operations and trading relationships for decades and a few for more than a century, global value chains now contain activities that are tightly integrated and often managed on a day-to-day basis. This means that firms and workers in widely separated locations affect one another more than they have in the past.

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• Studies show that Between 50% &70% of global trade is in intermediate goods and services . The income created within GVCs has doubled, on average, over the last 15 years; in China, income associated with GVCs has grown six-fold.

• According to the OECD the importance of GVC in global economy can be summarized as follows:

The growth of global value chains (GVCs) has increased the interconnectedness of economies and led to a growing specialization in specific activities and stages in value chains, rather than in entire industries.

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Trade-related participation in GVCs contributes to economic growth through the gains that firms achieve from specialization and improved productivity for both imports and exports (access to new technology and knowledge ).

This is equally the case for investment, where the nature of the interaction between foreign firms and domestic producers can explain more of the potential productivity spill-overs than the level of FDI.

Recent OECD analysis highlights that more than half of the contribution of foreign affiliates to domestic value-added is through labor income that stays in the domestic economy.

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Developing countries are increasingly involved in GVCs which offer an opportunity to integrate in the world economy at lower costs; even if the gains from GVC participation are not automatic.

• In order to maximize the positive impact of the GVCs activities;

strong social, environmental, and governance frameworks and policies are to be established,

an efficient service sector should be available

the development of a financial system to alleviate Cash constraints and facilitate GVC participation.

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Observation of international core labor standards, including establishment and enforcement of occupational health, safety, and environmental standards.

countries should develop an efficient innovation system that facilitates investments in knowledge, technology dissemination, skills upgrading and entrepreneurship.

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Potential Draw backs ?

• National policies that are established /or not, which intentionally /or not , motivate re-location of lead firms based on issues related to :

Lack of adequate environmental policies in host economies including energy policies and cleaner production initiatives.

Non-compliance with international core labor standards, including establishment and enforcement of occupational health, safety, and environmental standards and related

capacity-building for compliance.

Examples: IKEA; SWAROVSKY CRYSTALS

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Potential Draw backs to developing countries

Lead firms should play a key role in co-ordinating efforts with member firms in developing countries to become greener; through product design and specifications, the codification of business processes, supporting audits, knowledge transfers, co-innovation, and so on.

Ideally regulators of developed countries from which those lead firm originate, should move ahead in promoting greener supply chains. This of course can become a sensitive issue which increases pressure on small firms in developing countries; hence such a move should be accompanies with incentives and a role of national and global regulations.

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Governance & complexity Of GVC

• Types of Value Chain Governance

The connections between industry activities within a chain can be described along a continuum extending from the market, characterized by "arm’s-length" relationships, to hierarchical value chains illustrated through direct ownership of production processes. Between these two extremes are three network-style modes of governance: modular, relational, and captive.

Network-style governance represents a situation in which the lead firm exercises power through coordination of production vis-à-vis suppliers (to varying degrees), without any direct ownership of the firms.

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• Five different types of global value chains have been

identified:

1- Markets. Markets are the simplest form of GVC governance. GVCs governed by markets contain firms and individuals that buy and sell products to one another with little interaction beyond exchanging goods and services for money.

The central governance mechanism is price.

The linkages between value chain activities are not very "thick" because the information & knowledge that needs to be shared is relatively straightforward.

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• Local Example:

• Matelec- produce electric transformers –utilize imported materials and intermediary products supply local and regional markets.

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2- Modular value chains.

most market-like of three network-style GVC governance patterns. Typically, suppliers in modular value chains make products or provide services to a customer's specifications.

Suppliers in modular value chains tend to take full responsibility for process technology and often use generic machinery that spreads investments across a wide customer base. This keeps switching costs low and limits transaction-specific investments, even though buyer-supplier interactions can be very complex.

• Linkages are necessarily thicker than in simple markets because of the high volume of information flowing across the inter-firm link, but at the same time codification schemes such as design or production, can keep interactions between value chain partners less dense.

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• Example:

• Co-packed food product brands such as Maxim ,…

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3- Relational value chains. There is mutual dependence regulated through reputation, social and spatial proximity, family and ethnic ties, and the like. Since trust and mutual dependence in relational GVCs take a long time to build up, and since the effects of spatial and social proximity are, by definition, limited to a relatively small set of co-located firms, the costs of switching to new partners tends to be high.

• Dense interactions and knowledge sharing are supported by the deep understanding value chain partners have of one another, but unlike the codification schemes it will be time-consuming to re-establish with new value chain partners.

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• Example:

• Family businesses that grow and diversify and create complimentary businesses.

• Boeing and rolls royce

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Types and levels of complexity

4- Captive value chains. Small suppliers tend to be dependent on larger, dominant buyers. Such networks are frequently characterized by a high degree of monitoring and control by the lead firm. The asymmetric power relationships in captive networks force suppliers to link to their customer in ways that are specified by, and often specific to a particular customer, leading to thick linkages and high switching costs all round.

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5. Hierarchy. This governance pattern is characterized by vertical integration (i.e. "transactions" take place inside a single firm). The dominant form of governance is managerial control.

. (Much of the literature that seeks to categorize cross-border economic activity emphasizes only two options: market or hierarchy. Firms either invest offshore directly or buy goods and services from foreign firms. A smaller body of literature has noted the prevalence of network forms of organization where there is some form of "explicit coordination" beyond simple market transactions but which fall short of vertical integration. While this is a useful insight, there is convincing evidence that not all networks are the same. The GVC framework specifies three types of network governance (modular, relational, and captive) along with the two traditional modes of economic governance (markets and hierarchies)).

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• Example:

Agro-food brand owners and networks working with several rural coops to produce different types of ready to eat food products.

Pepsi-cola Lebanon: import raw material and know how; highly dependent on external information (codified knowledge) and sell to domestic markets.

• Hierarchy

• Example: Haute couture entities such as Elie saab and Reem Acra, Zuhair Murad,..

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Influence of production standards

• Next slide illustrates the five global value chain types arrayed along the dual spectrums of explicit coordination and power asymmetry.

• The small line arrows represent exchange based on price while the larger block arrows represent thicker flows of information and control, regulated through explicit coordination.

• This includes instructions coming from a more powerful buyer (or manager) to a less powerful supplier (or subordinate), as in captive global value chains or within the confines of a hierarchy, as well as social sanctions regulating the behavior of more or less equal partners, as in relational global value chains.

• In the case of modular global value chains, thick information flows are narrowed down to a codified hand off at the inter-firm link, leaving each partner to manage tacit information within its own firm boundaries, or perhaps by combining some other form of global value chain governance, such as captive or market-based, for part of the chain. While relationships between the relational and modular suppliers and the firms providing their material inputs and components are displayed as market-based in the figure, they could equally take other forms.

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• Explicit coordination: communicates results, decisions or command from one manager to another, usually from a higher command to a lower command.

• Power asymmetry: absence of balance in management power.

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Materials

Customers

Suppliers

Price

End Use

Market Modular

Lead

Firm

Component

and Material

Suppliers

Turn-key

Supplier

Relational

Captive

Suppliers

Captive

Lead

Firm

Component

and Material

Suppliers

Valu

e

Ch

ain

Hierarchy

Integrated

Firm

Low High Degree of Explicit Coordination

Degree of Power Asymmetry

Lead

Firm

Relational

Supplier Full-package

Supplier

GVC Governance Types

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Indicators for measuring GVC

• Trade, growth and employment

While there are concerns that imports threaten domestic jobs, the reality is that jobs are increasingly created as part of global value chains. Trade flows in value added terms indicate where jobs are created and highlight the benefits of trade for all economies involved in the value chain. Understanding interdependencies within global value chains are key to explaining the competitiveness of countries and the productivity gains that can be made.

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• The OECD, in co-operation with WTO, has built a new database of trade flow in value added terms based on a global model of international production and trade networks.

• Trade in value-added describes a statistical approach used to estimate the source(s) of value (by country and industry) that is added in producing goods and services for export (and import). It recognizes that growing global value chains mean that a country's exports increasingly rely on significant intermediate imports (and, so, value added by industries in upstream countries).

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• The Inter-Country Input-Output (ICIO) model links internationally input-output tables from 58 countries (one of these countries being the “rest of the world”) and accounts for more than 95% of world output.

• The OECD ICIO model allows the analysis of GVCs from a truly global perspective detailing all transactions between industries and countries for 37 industries. In contrast, previous research often used input-output data for a limited or even single country,

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Other GVC measurement indicators utilized:

1. Degree of Participation in a GVC- is defined as the share of foreign inputs(backward participation) and domestically produced inputs used in third countries 'exports (forward participation) in the overall exports of a country.

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Indicators for measuring GVC Source: OECD trade policy paper 159

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2. The length of GVCs: how many production stages in the GVC?

• Index=The index takes the value of 1 if there is a single production stage in the final industry and its value increases when inputs from the same industry or other industries are used, with a weighted average of the length of the production involved in these sectors.

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• The distance to final demand: what is the position of a country in the value chain?

• Once the depth and length of particular GVCs is assessed, the important question is where countries are located in the value chain. A country can be upstream or downstream, depending on its specialization. Countries upstream produce the raw materials or intangibles involved at the beginning of the production process (e.g. research, design), while countries downstream do the assembly of processed products or specialize in customer services.

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• a measure of “upstreamness” that we can refer to as the “distance to final demand”. Starting from one industry in a given country, the index measures how many stages of production are left before the goods or services

produced by this industry reach final consumers.

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EXAMPLES OF LOCAL GVC

• Agro-food GVC- belonging to the ..

• Haute couture GVC-Belonging to the luxury sector.

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Example of international AGRO-FOOD

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Each color represent a location

Haute couture GVC

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Each color represent a location

Potential of local GVC

• Chocolate

• Hand made food specialty products

• Financial services

• In ICT services

• Health Care

• Food service

• Jewelry sector.

• Other creative sectors

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Integration of SMEs in GVC

• GVCs are created by private firms, but those firms differ greatly in their propensities for partnership and in their success at integrating themselves in the modern international economy.

• The co-ordination of GVCs is generally the role of large multinational enterprises (MNEs);these lead firms set the rules of the game and largely determine the location of high-value activities and the conditions under which other firms participate in GVCs.

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• Mutual benefits however are the prerequisite condition for MNCs and SMEs to consider engaging in a GVC.

• On the one hand, MNCs can enhance their innovative capacity and productivity by working with SMEs. SMEs usually bring local knowledge and human resources that help MNCs to quickly establish a strong position in local markets.

• On the other hand, working with MNCs will on micro level:

enhance the reputation of SMEs.

SMEs could also access expertise, advice, and finance from their MNC partners, which will help SMEs to

improve their product quality and production process,

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which in turn enhance the competitiveness of the SMEs.

In addition, being a supplier to an MNC will help an SME achieve economies of scale,

access to overseas markets,

reinforce business prospects and build confidence.

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• At the macro level

• In 2007, SMEs in the United States accounted for 28% of US direct exports, but because they also sold to larger firms that export (i.e. engaged in indirect exporting), they actually accounted for 41% of US value-added through exporting. Such indirect exporting alone supported an estimated 2.1 million jobs. The insertion of SMEs into GVCs is especially important in the developing world, where these firms represent approximately 80-90% of total employment

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• Firms that join GVCs can find themselves in a stronger position to upgrade their skills. That upgrading takes a variety of forms.

functional upgrading, which occurs when firms acquire capabilities to provide competitive products or services in new segments or activities of a GVC that are associated with higher value-added.

process upgrading, the phenomenon by which firms acquire capabilities to process tasks with significantly higher efficiency, lower defect rates, and process more complex orders than rivals.

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Product upgrading is realized when firms acquire capabilities to supply higher value-added products compared with those by rivals through superior technological sophistication and quality. It also involves the capability to introduce novel products faster than rivals.

Chain upgrading, which is realized when firms acquire capabilities, often leveraging the knowledge and skill acquired in the current chain, to participate in new GVCs producing higher value-added products or services.

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• The challenge of SME firms and their countries is to be able to ensure their progressive movement upwards in terms of value addition in a GVC, by moving up the technological ladder and achieve economy-wide development impacts from integrating into GVCs.

• The key point remains that initial entry into GVCs, and a firm’s further rise within them, require that enterprises acquire and constantly improve their edge over the competition.

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What are the success criteria for SME integration.

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What are the success criteria for SME integration

Practices leading to SMEs having a successful GVC relations

• SME related attributes:

- In addition to the attributes mentioned in the previous table on MNC criteria :

Performance evaluation; MNC to conduct frequent performance evaluations before selecting and during operation on order to what level to engage in the business relation.

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Supplier development: Establish a supplier development program to help SME grow within a GVC. It becomes evident that having too many suppliers is counterproductive (Conference Board of Canada 2009); therefore, consolidation is taking place across many GVCs, thus MNCs could focus more on the long term relationships with a few key suppliers. Supplier development programs strengthen the capacity of SMEs, as well as the value chain itself.

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• External attributes: also affect the long-term relationship between MNCs and SMEs.

Business environment:

Open markets,

Ease of opening a business and permitting or licensing

streamlined trading procedures,

Complexity of Export-import procedures

high transparency in rules and regulations,

and absence of corruption.

Environmental and energy policies.

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Infrastructure:

Logistics and transportation are crucial in connecting GVCs. Ports, hubs, roads and railway tracks are physical infrastructure that ship goods, services, and people to different geographic locations.

Informational infrastructure links companies across the world, making communication and interaction easily achievable.

Overall, external factors impact on trade costs, hence the competitiveness of GVCs and the long-term success of the MNC–SME relationship.

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Situation of Lebanese SMEs

Factors Supporting the participation of Lebanon in GVC

Internal Low Medium High

Quality of product x

Price x

Product delivery x

Financial soundness x

Production capacity x

flexibility x

Standards& certification x

Geographic location x

ICT level of business operations x

Talent and innovative - x

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Situation of lebanese SMEs

Factors Supporting the participation of Lebanon in GVC

External Low medium High

Business environment X

Physical and informational infrastructure X

Environmental and energy policy X

Sector specific external factors

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Question

• Potential of Lebanese SMEs to participate more actively in GVC participation or move further downstream the value chain and decrease distance to consumers?

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Thank you for your attention

Contact: Name Phone: Email:

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enhancement of the business environment in the … · ebesm project 2. what are global value chains...

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